Wednesday, July 11, 2007

The Size of Impending Tax Hikes

As is well known, future Congresses will need to either raise taxes or reform entitlement programs to close the looming fiscal gap. A recent letter from CBO suggests one way this future history might play out: Congress can just wait and let the passage of time do the work.

CBO describes this outcome as follows:

The first tax scenario CBO examined assumes that current tax law is unchanged for the individual income tax through 2050. All other taxes are assumed to remain constant as a share of GDP. Although statutory tax rates are not changed, income growth raises effective tax rates....By CBO’s calculations, this scenario would raise roughly the amount of revenues needed to finance the spending path in which excess health care cost growth is 1 percentage point per year in the future. [That is, health care costs per beneficiary grows 1 percentage point faster than per capita GDP.] However, it would not be sufficient to finance the spending path in which such cost growth is 2.5 percentage points per year.

Depending on the path of health spending, the automatic tax increases built into current law may be enough to close much of the long-run fiscal gap. These numbers include, I believe, the automatic expiration of the 2001 and 2003 tax cuts, as well as the bracket creep that occurs as economic growth pushes people into higher tax brackets.

Of course, one should not underestimate the size of the implied tax hikes. For the median married taxpayer with two kids, the average effective tax rate (including both income and payroll taxes) rises from 20.0 to 37.6 percent. The marginal tax rate for this taxpayer rises from 30.3 to 50.3 percent.

About Me

I am the Robert M. Beren Professor of Economics at Harvard University, where I teach introductory economics (ec 10). I use this blog to keep in touch with my current and former students. Teachers and students at other schools, as well as others interested in economic issues, are welcome to use this resource.